Below is an article I wrote for my blog, I'd be interested in your feedback. PS. I'm not a broker and I don't work for a bank, but I am in the industry...
Everyone is talking about break costs on mortgages and how they are anti-competitive and are completely unfair. From the outside I can see how people may think that banks and non-banks are just cashing in with this fee, but I can tell you it's definitely not the truth. I'm going to share a couple of facts with you...
(PS. This entry isn't about defending break costs, it's just explaining why they exist)
Establishment Fees
Most banks will charge you around $600 to establish a loan, but do you think that's all it costs? Of course not! Here's the costs that are involved in the process:
* Marketing - to get the customer interested in the first place
* Enquiry - The customer will either call a call centre, visit the website or talk to branch staff before making an appointment with a lender - these are all staff costs (or website costs) to be paid
* Application - The mobile lender or branch lender will spend an hour or more with the customer, then another hour or more putting the loan file together ready for submission. There's a couple more hours of wages to be covered. If you requested a mobile lender, then you have to include travel expenses such as fuel and car leasing costs
* Valuation - Most banks include a valuation within the application fee, there another couple of hundred dollars
* Credit - A credit analyst has to be paid to analyse the application, this can take over an hour depending on the complexity
* Reference checking - Staff must be paid to perform employment checks, credit reports etc.
* Documentation - Staff must be paid to draw up the loan documentation, then there's the costs for all the paper and printing and postage etc.
* Settlements - Staff must be paid to check the returned documents, then arrange settlement with the solicitors, arrange the cheques and either attend settlement or arrange for a settlement agent to attend (who will also have to be paid)
* Post-Settlement - Staff will have to be paid to register the mortgage documents with the relevant government offices
So do you think all of that can be done for $600? No way in the world! That doesn't include the ongoing costs of training staff, ongoing credit policy development, ongoing product development, ongoing (and ever increasing) compliance and regulatory expenses, and a thousand other things that go on behind the scenes.
If the loan was written by a broker you can replace some of the above costs with the broker's commission payment. At the end of the day, the costs will be fairly similar whether it's done directly through the bank or via a broker.
Won't the bank make those costs back after a couple of interest payments?
No way Jose! When a customer pays a few hundred or a few thousand dollars in interest each month, it doesn't just go straight to the bank's profit! If the funds have come from customer deposit account, then the bank has to first pay interest to those customers. The media goes on about standard bank accounts paying only 0.1% interest or whatever, but anyone with more that a few dollars in their account will be smart enough to open a proper savings account, pretty must every bank offers these types of accounts, and the market leaders like BankWest and ING will offer you a pretty serious rate on your savings.
Let's take Suncorp as an example. Their Everyday Options Sub-Account (which anyone can open) pays a rate of 7.15%. Their Back to Basics home loan has a rate of 8.79%. So on a loan of $400k (which is slightly above average, depending on the bank and the state) the bank collects $2,930 in interest, but then has to pay $2,383 in interest to their customers. So that leaves $547 a month. Take out of that the staffing and infrastructure costs of maintaining the accounts, as well as a thousand other things, and the profit margin on a loan per month is very little. If the loan was funded through securitisation, the profit margin will be a LOT less now that we're well and truly in the credit crunch.
The fact is that it takes around 3-4 years for the average mortgage to become profitable. This wouldn't be an issue if people kept their loans with the one lender for more that 3-4 years, but many of them are continually told to go out chasing a lower rate, so they chop and change banks every couple of years. Do you think the banks would be happy for so many of their mortgages to be closed at a loss? No way in the world!
So here's what they do - if you payout your loan within a certain time frame (anything from 2 to 5 years, depending on the lender) they will charge you an fee to ensure they haven't made a loss on your loan. Sound fair enough?
What would happen if they were forced to ditch break costs?
It's pretty simple - they'd either have to increase establishment fees so that they covered the full cost of establishing the loan (which would be in the thousands) or they'd have to increase interest rates to ensure loans are profitable much sooner.
So here's the decision for customers - should we only be punishing those customers who shop around for new honeymoon rates every couple of years, or should we punish everyone including the loyal customers who do keep their loan with a lender for the long term? If establishment fees had to be increased to cover the full cost, many first home buyers simply wouldn't be able to come up with the upfront costs and would be further squeezed out of the market.
For the banks and lenders, it doesn't matter either way, as long as they make a profit. But for the customers, surely the majority would agree with only punishing the rate shoppers rather than punishing everyone?